Five myths about the crash and its solution

Allen Sloan’s list of “5 misconceptions about the financial crisis and its aftermath” is not a bad place to begin. But it’s only the beginning.

1 The government should have done nothing.

There’s an idea gaining currency that everything the government did, from the Troubled Assets Relief Program (the now infamous TARP) to the Federal Reserve’s innovative lending programs and rate cutting, just made the problem worse. And that we should have simply let markets do their thing.

Wrong! Wrong! Wrong! During the dark days of 2008-09, when giant institutions like Washington Mutual and Wachovia and Lehman Brothers failed and the likes of Citigroup, Bank of America, AIG, GE Capital, Merrill Lynch, Morgan Stanley, Goldman Sachs and huge European banks were near collapse, letting them all go under would have brought on the financial apocalypse. We could well have ended up with a downturn worse than the Great Depression, which was the previous time that failures in the financial system (rather than the Federal Reserve raising rates) begat a U.S. economic slowdown.

2 The government bailed out shareholders.

The real beneficiaries of the government bailout of financial institutions weren’t their stockholders — it was their lenders.

3 The Volcker Rule will save us.

Let’s get one thing straight. Washington is unwilling to change the financial system drastically, the way it was changed in the Great Depression’s aftermath. Rather than shrinking giant financial companies so that they’re no longer too big to fail — a process that Dick Fisher, head of the Dallas Fed, wonderfully likens to stomach-shrinking bariatric surgery — we’re trying to legislate the problems away. Hence a whole raft of new, tough-seeming — but almost incomprehensible — regulations.

4 Taxpayers are off the hook for future failures.

The FDIC’s detailed proposals sound great. But like the Volcker Rule, it will turn into a game of financial Whac-A-Mole as SIFIs end-run the rules once they are made final. For instance, it took me about three seconds to realize SIFIs could borrow at the operating-company level rather than at the parent company. (“It may be worthwhile to consider requiring a certain level of debt at the holding company,” Gruenberg said.) There will doubtless be dozens of other ways around the rules.

5 It’s the government’s fault.

It was the private market — not government programs — that made, packaged, and sold most of these wretched loans without regard to their quality. The packaging, combined with credit default swaps and other esoteric derivatives, spread the contagion throughout the world. That’s why what initially seemed to be a large but containable U.S. mortgage problem touched off a worldwide financial crisis.

Sloan’s list is a good place to start. But the biggest misconception—that the Too Big to Fail banking system can’t be changed—is still allowed to stand. The fact is, the banks that were initially nationalized should have remained nationalized, and then we would have been to get on with fixing the other problems, like the obscene levels of inequality and the way corporations are run by by a tiny group of privately elected boards of directors.

The consequence of not fixing those problems has been the even larger set of problems brought on by the Second Great Depression.